Why Whole Foods Market May Have a Big Problem

This past week, Whole Foods Market (NASDAQ: WFM) disappointed shareholders with earnings that fell below lofty expectations. In recent quarters, natural and organic publicly traded competitors like Sprouts Farmers Market (NASDAQ: SFM) and The Fresh Market (NASDAQ: TFM) have slowly added to their store counts, while Kroger (NYSE: KR) continues to expand its own natural and organic offerings in its own stores.

It is estimated that the U.S. organic food market will grow at a compound annual growth rate of 14% over the next few years. Combined, sales of natural and organic foods nationwide are nearly $100 billion. Despite these trends, Whole Foods Market may have a big problem going forward.

By LoneStarMike, via Wikimedia Commons

Recent earnings for Whole Foods MarketFirst-quarter 2014 earnings for Whole Foods Market saw the company's total sales rise by 10% to a record $4.6 billion. However, the company's comp-sales growth of 5.4% was one of the catalysts that sent the stock tumbling nearly 8%.

The other catalyst was the lowered outlook issued by the company, which predicted full-year sales growth of 11-12% (down from 11-13%) and comp-sales growth of 5.5-6.2%. For a company that has been surpassing 7% comp-sales growth in previous years, this past week's earnings report had the market wondering whether the growth is slowing down.

Potential problems in the Whole Foods Market growth storyDuring the conference call, Whole Foods Market said it expected to increase its current count of 373 stores across 40 states to at least 500 stores by 2017. Long-term, the company sees a U.S. market opportunity for 1,200 locations.

However, this introduces another problem for the company, self-cannibalization. Whole Foods has over 70 locations in California and nearly 30 in Massachusetts, while it has fewer than 10 stores in many states.

Store distribution may be one of the reasons for this comp-sales performance. It is difficult to tell whether competitors or the company's own stores are hurting its comp-sales growth. The fact that comp-sales growth for stores open for less than two years was 19.5% may just show that customers prefer to shop at newer Whole Foods Market locations.

Not only does Whole Foods Market need to pay attention to Sprouts Farmers Market and The Fresh Market, which saw their sales increase by 24% and 13% in their most recent quarters, respectively, it must also watch mainstream supermarket chains like Kroger.

Kroger's 2,414 supermarket locations across 31 states pose a serious threat to the long-term growth potential of Whole Foods Market. The Simple Truth natural and organic in-house brand is a big advantage for the supermarket giant. In Kroger's most recent earnings conference call, CEO W. Rodney McMullen commented that because of the company's large size, it can offer lower prices on organic and natural foods.

Furthermore, Kroger stated that even though its natural and organic department is only its sixth- or seventh-largest department overall, it is the fastest-growing on a percentage basis by dollar amount. Kroger also has plans to add more aisle space for the department in the near future.

Competition from unlikely sourcesCustomers have more reasons than ever to not locate their nearest Whole Foods Market. Annie's, the natural and organic provider of pastas, meals, pizzas, dressing, and snacks at over 26,500 retail locations in the U.S. and Canada, is found in not just Whole Foods Market but in many mainstream chains around the country.

United Natural Foods is the largest distributor of natural and organic products in the U.S. and Canada. It is also the single largest third-party supplier for Whole Foods Market, where it accounts for 32% of the grocer's total purchases. However, unlike the advantage Kroger has with its Simple Truth in-house brand, Whole Foods doesn't have exclusive use of United Natural Foods.

United Natural Foods continues to add customers regularly and it now serves companies like Safeway, Costco, and even Kroger.

Competition is also coming in the form of local, regional, and international supermarkets, natural food stores, farmers' markets, and even online retailers. Restaurants also pose a threat as more of them become transparent about the exact ingredients in their menu items, with some sections of their menus specifically aimed at natural and organic diners.

Sprouts Farmers Market. Credit: Company website.

Foolish bottom lineWhole Foods Market is the victim of an increasingly competitive natural and organic environment. As a result, customers are finding alternatives at their local neighborhood markets and mainstream supermarkets that are expanding their own natural and organic selections.

Moreover, in today's world where saving time is a priority, it may make sense for customers to do all their grocery shopping at a single location that offers a wide selection of foods that includes natural and organic foods. In the end, growth beyond its main core of followers may prove difficult for Whole Foods Market -- especially if other pure natural and organic chains also continue expanding.

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John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Michael Carter has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale, The Fresh Market, and Whole Foods Market. The Motley Fool owns shares of Costco Wholesale and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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No one that I know who shops for organic foods wants to buy their healthy choices at a store that sells Hot Pockets, a la Krogers, or any chain that sells mostly unhealthy foods. That said, WFM like any other company that reaches a hefty market cap, faces slowing growth, but this doesn't mean it will not double, triple or more in size. The question really is, do I take a chance and wait for the share price to come down and maybe miss the opportunity, or do I buy now and wait for the p/e multiple to come down as the company grows? If you're a longer term investor, you buy now, into a great American story, a theme that will last a long, long time. If you're a short term trader, you move on.

WFM has been until recently (Feb'14 Motley Fool Stock Advisor issue) among David's best buys for quite a while. You've already knew latest financial results and projections for 2014 and claimed to "focus on long-term growth, which could last more than a decade". Looks like your decade was stated in days rather than years!

Not one of your better articles. The real writers must be on vacation. You show little to no knowledge of the natural foods industry and I can only guess you hacked the computer of a Seeking Alpha scribe. Tom Gardner would pull his hair out(if he had any left)if he read this article. WFM in trouble because of Srous or Fresh Market? Seriously? We pay for that opinion? I may be cancelling soon.

This writer obviously doesn't know the difference between "natural" and "organic" because he shouldn't be using the words together. Botulism is natural but that doesn't mean it's good for you. I've shopped at Sprouts and they don't have a very big organic selection, not like Whole Foods. I think the reason Whole Foods is struggling is because the price of organic is so high that a lot of people can't afford it. I golfed with a guy this past week that was an organic farmer and I asked him why it was so expensive. His reply was "labour costs. I can't spray weeds, it has to be weeded by hand and that takes time. Plus the yield isn't quite the same. If you spray for bugs, your yield will be higher". Made sense to me. BTW, I don't own any Whole Food stock. I just shop there.

<Whole Foods is struggling is because the price of organic is so high that a lot of people can't afford it.>

This is CERTAINLY true at "Whole Paycheck". It is not necessarily so, or maybe not to the degree, at Whole Paychecks local competition in Portland OR.

The writers at MF (it seems ALL of them) ignore this risk for WFM and have as far as I can tell done no as in zero research into it. I am not an investor in WFM for this risk reason. That does not mean I don't admire the courage and intelligence of WFM to take that risk and cream off the well heeled buyers of these products. Just because the BMW and Volvo set finds WFM affordable and wonderful to shop at, does NOT mean that train can go on forever. And unlike Alyce Lomax, that does not to me make them such a people friendly place or what I perceive as "pro-social" When only the upper segment of the income stream can afford to shop in your store, regardless if it is Tiffany & Co or WFM, I do not consider your business broadly applicable, NOR good for society.

Now, if WFM can bring down its costs so EVERYONE can afford to shop there full time, offer up the products that the trendy and organic lovers want, treat its employees royally and still turn a great profit, I WILL BE IMPRESSED ENOUGH to be an investor. Until then, y-a-w-n dont disturb my nap.